6 minute read
Last month, I wrote to you in our Saturday Morning Pour highlighting the issue between income, spending, and credit card debt for consumers.
You can read it here and see all the troubling data - “On Borrowed Time?”: Taking A Closer Look at The U.S. Consumer – but the gist was that since Q1/2020, households have seen “real” (inflation-adjusted) income lag against spending and credit card debt.
Put simply, they were spending and borrowing much more than what they were making.
Now, I don’t believe this is a good recipe. And I am sure you would also agree.
But, while it’s clear from headlines that U.S. households keep borrowing and borrowing to consume – with credit card debt hitting a record high of $1.05 trillion recently1 - the fallout is beginning to show. . .
How?
Well, I’m talking about the rapidly rising debt delinquencies on consumer loans. . .
And as a financial advisor, it’s important to try and monitor these things in order to relay information to clients and keep them informed.
So, let’s take a closer look at all this.
Credit Card Data And Other Loans Showing Stress As Delinquencies Rise
Now, I’ve long argued that the credit cycle – aka the loan supply-demand balance – is decelerating.
Simply put, banks are lending less. And consumers are borrowing less (except for credit cards).
And while the mainstream media continues pushing the “soft landing” narrative – I remain skeptical.
For instance, it appears that the math just doesn’t add up for households to keep on piling up debt - unless forced to – in the face of record high2 average APRs (annual percentage rates).
This is costing households billions in interest payments.
Making matters worse, according to a 2023 study by Bankrate, nearly half (47%) of cardholders now carry a balance from month to month, compared to 39% in 2021. This trend coincides with increased missed payments, and TransUnion data shows the average credit card carry balance exceeding $6,000 - the highest level in over a decade.
Meanwhile, loan delinquencies – meaning missed or late payments – have surged far above pre-pandemic levels.
Note that Just take a look at delinquency rates on total consumer loans, credit card loans, and credit card loans from banks that aren’t in the top 100.
Keep in mind there are over 4500 banks in the U.S. – so excluding the top 100 largest banks shows stress in the medium-smaller banks. Which have already faced heavy pressure year-to-date from deposit flight, declining asset values, and an imploding commercial real estate sector.
Meanwhile, a recent report4 by the New York Fed raises concerns about potential economic vulnerabilities. While the American consumer has displayed surprising resilience, delinquency rates on credit cards and auto loans have spiked to their highest levels since the Great Recession.
This upswing suggests that the Federal Reserve's aggressive interest rate hikes are
starting to impact consumers, making it harder for them to manage their debts.
· Notably, researcher Wilbert van der Klaauw from the New York Fed highlights that "this signals increased financial stress, especially among younger and lower-income households."
While the U.S. economy has weathered recent challenges, these rising delinquency rates warrant close attention as they may indicate underlying
financial strain and potential future economic risks.
Now, all this is troubling on its own. But there’s one issue I can’t seem to shake when thinking about it. . .
“If the media pundits calling for a soft landing believe the tight labor market is the tailwind to the economy, what does rising missed debt payments mean even as unemployment is low?”
Or said another way, the recent surge in credit card and auto loan delinquencies presents a puzzling contrast to the seemingly healthy state of the consumer, characterized by a strong labor market and rising nominal wages.
Meanwhile, let’s examine “real” retail sales data as a "percent-off-high" to gain insights into long-term trends and underlying volatility of the data.
According5 to this, real retail sales currently sit at -3.39% below their all-time peak as of January 2024 – which often indicates recession historically (shaded lines mean recession in the chart below).
Again, if the labor market is booming and carrying the soft-landing narrative, what does this tell us as real retail sales decline and credit delinquencies rise?
If things look this bleak in a low unemployment era, imagine how quickly things could go bad if unemployment begins rising. . .
Going Forward: Beware Stepping on Cracks
If there’s one thing we’ve learned from the economist Hyman Minsky, it’s that private debt cannot rise forever.
It’s a constraint as eventually, households must divert more and more income to servicing debt.
And with such high APR’s costing households billions in extra money, it indicates that the debt binge may be nearing its end.
And I believe this has widespread implications for economic growth in two big ways:
1. Less credit extended means less demand somewhere else (remember, when an entity borrows, they’re buying or investing in something now which fuels some sort of demand). For example, if there’s a $200 billion increase in total credit card debt, that implies $200 billion in added sales throughout the economy. And vice versa.
2. Long term, more debt is deflationary – aka when prices begin falling from weak demand or too much supply.
Just as increased debt may stroke inflation in the short term (because of all the debt-fueled buying), eventually debtors must divert more and more of their income to repay it. This implies they have less money to spend in the future, thus becoming a drag on future growth.
This is why – historically – the “inflationary boom” is followed by a “deflationary bust”.
Meaning it’s always cyclical. What goes up comes back down, and vice versa.
And like one of my favorite Austrian Economists – Ludwig Von Mises – once noted: the bigger the boom, the bigger the bust.
Or as I like to think about it, the more you drink, the bigger the hangover.
As always, just some food for thought while challenging the consensus.
Sources:
1. https://fred.stlouisfed.org/series/CCLACBW027SBOG
2. https://www.consumerfinance.gov/about-us/blog/credit-card-interest-rate-margins-at-all-time-high/
3. https://abcnews.go.com/US/credit-card-users-avoid-mounting-debt-bills-reach/story?id=106479070
4. https://www.axios.com/2024/02/06/americans-credit-card-auto-loan-delinquencies
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